Continued concerns about currency
weakness and resulting inflationary pressures prompted the Central Bank to
raise the benchmark interest rate for the fourth consecutive month.
However, to avoid choking off the economy with an ever tighter monetary
policy the new Central Bank administration decided to raise its inflation
target allowing for a more accommodative stance.

Inflation gaining speed as currency stabilizes but concerns loom
In January, the National Statistical Office (IBGE) reported that the
mid-January consumer price index (IBGE-IPCA 15), which covers monthly
price increases up to the 15th of every month, rose 1.98% over December.
The January data came in well below the 3.05% monthly increase observed in
December. Nevertheless, the annual inflation rate continued to rise from
11.7% in December to 13.2% in January. Last year’s currency weakening and
rising oil prices have exerted substantial upward pressure on prices in
the past months. As a result, the Central Bank decided to raise this
year’s annual inflation target to 8.5%, up from the 4% target previously.
In addition, monetary officials revised the inflation objective for 2004
from the previous 3.75% to 5.5%. The hike in the inflation targets was
largely anticipated since the new Central Bank president, Henrique
Meirelles, who was appointed by Lula, had already indicated that reaching
the previous inflation targets was overly ambitious and reaching the
targets would require a monetary policy too tight under the current
economic slump. But even the lowered targets seem ambitious. Currently,
the annual inflation rate remains well above Central Bank target for this
year and the Consensus does not expect the Central Bank to meet its
target, with consumer prices anticipated to rise at a much more pronounced
11.2% pace this year. Similarly, at 8.1%, next year’s inflation rate is
seen significantly above monetary officials’ objective. Consequently,
monetary authorities are unlikely to have significant leeway to lower
interest rates significantly in the near future. Consensus Forecast
participants had already factored last year’s currency shocks into their
inflation forecasts. The recent currency stability, if persistent, could
favour an improved inflation scenario for this year. Since the elections
in October - which had brought the real close to the 4.00 reais to the US$
threshold – the real has strengthened significantly, appreciating four
consecutive months and strengthening by 12.2% to the US$ compared to its
weakest level on 22 October. In January, the currency appreciated again –
by 0.2% - over the prior month. However, the strengthening was more modest
than the 2.9% rate observed in December, as investors continue to evaluate
the new administration’s economic policy and governance prospects. The
real strengthening abated further in early February, as concerns over the
stability of the governing coalition in Congress raised additional fears
about economic policymaking under the Lula administration. Nevertheless,
the recent stability in the currency appears to have infused panellists
with heightened optimism about the strength of the real this year, as the
Consensus now expects the currency to end the year at 3.60 reais to the
US$, which would represent a 1.9% annual depreciation only over 2002. The
forecast for 2004 sees the currency depreciating at a more pronounced
8.0%, closing at 3.96 reais to the US$ by year-end.

Central
bank hikes interest rates for fourth consecutive month
On its 22 January meeting, the Central Bank decided to raise the benchmark
SELIC rate from 25% to 25.5% - the fourth consecutive monthly hike.
Monetary authorities justified the tightening with continued concerns
about lingering inflationary pressures and uncertainty regarding the
exchange rate in light of a possible conflict in Iraq. Participants have
revised their interest rate forecast again this month, anticipating the
SELIC rate to drop moderately to 19.7% by the end of this year, which is
0.4 percentage points above last month. In fact, panellists anticipate the
Central Bank to be able to lower rates within the first quarter of this
year if currency uncertainty subsides. Furthermore, the easing of
inflationary pressures will lower interest rate further next year to
16.3%.